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Why a loan may make a better gift

You've worked hard all your life and saved hard too. Now you're retired and enjoying the fruits of your labour. So when you see your grown up children struggling to make their financial needs meet, it's only natural for you to want to help them out.

But before you grab your cheque book, you should be aware of the different financial implications of your gift or loan. Myron Knodel, C.A. and Manager, Tax Planning, Advanced Financial Planning Support at Investors Group, warns that a gift is just that—"a complete, irrevocable transfer of all rights of ownership of the cash or item being given." Your gift is non-taxable, as it is not considered income to the person receiving it. With a gift, the money now belongs completely to your adult child, to do with whatever he or she wishes regardless of your intentions.

Payback time

A loan is a different story. "There is a legal obligation by the person receiving the loan to repay it," Knodel says. "Conditions of repayment as well as conditions for the use of the money may be set and collateral may be secured, in much the same way a bank operates."

Loans are more complicated in terms of taxation. If, for example, your interest-free loan is invested by your son in an interest-yielding investment, interest income must be reported and tax on it paid by you. In contrast, if the money was a gift, your son would pay the tax.

If you are charging your son at least the prescribed rate of interest, you report that interest as income and your son reports the interest income earned on the investment. For income tax purposes, your son may be eligible to claim a deduction for the interest paid to you.

Times of trouble

The situation gets further complicated if your child has serious financial difficulties. If you have loaned your son money and his problems escalate to the point where creditors become involved, you become just another unsecured creditor—unless the loan provisions were written to include secured collateral. A lawyer may be best equipped to arrange for securing the loan which will protect your financial interest in such a situation.

'Til divorce do us part

What if you gifted money to your daughter and her marriage dissolves? Rules vary from province to province, Knodel notes but generally, "if the gifted money is used to purchase non-family assets, its value may be excluded from the division of assets on dissolution of the marriage."

It is also suggested you indicate in writing that the gift or property purchased from the gifted money not be divided in the event of a marriage breakdown. In some provinces, this exclusion may extend beyond the value of the original gift to include the income or capital gain realized from the gifted money.

If the funds went towards the purchase of a family asset, like renovations to the family cottage, or to the purchase of a family car, it would be considered a family asset, and its value may be divided. If, however, the money was loaned and used to acquire a family asset, the loan amount may be considered a reduction in the equity of the family assets, thus excluding the loaned amount from division. When loaning funds, it's always important to prepare proper documentation so that those intended to be responsible for repayment are held responsible.

Cheque out your options

Gifting or lending money can become a complicated issue, depending on your financial situation and the situation of the child you plan to help out. Other options may be available to you, as well. So before your write out that cheque, be sure to check in with your Investors Group Consultant and do what's best for everyone involved.

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This article, written and published by Investors Group Financial Services Inc., is presented as a general source of information only and is not intended as a solicitation to buy or sell investments, nor is it intended to provide professional advice including, without limitation, investment, financial, legal, accounting or tax advice. For more information on this topic or on any other investment or financial matters, please contact your Investors Group Consultant.